R.I.P. $ Carry Trade. We Hardly Knew You

Charts: The S&P 500 closed at 1118, up .4%. The Nasdaq has broken away from the hard resistance of 2200 that has plagued it for two months. The Nasdaq and small caps are providing leadership, which is good. The broad index is feeling resistance at 1120, a Fibonacci number.

Fundamentals: American existing home sales came in much better than expected while Q3 GDP was revised downward. The good and bad news is a wash for today’s fundie outlook. The big news is the ongoing unwind of the dollar carry trade. As investors rush to cover their short dollar positions we are learning more about the carry trade. The Brazilian large cap index (EWZ) has been clobbered while Brazilian small caps (BRF) have held up. The Brazilian small caps must not have been on the carry traders' menu while large caps were; it is worth noting that a weaker currency helps Brazilian large caps on a fundamental basis. American small caps (IWM) are benefiting from the demise of the carry trade because they weren't much of a carry trade destination, but American large caps are doing pretty good. This could mean that US large caps also were never much of a carry trade destination, but it is more likely that carry trade investors are covering dollar short positions while at the same time holding their US large cap long positions. This speaks to the carry trade being less leveraged than we thought, more cash based. Chinese stocks are getting slammed since the Yuan is pegged to the dollar and it is now rising, potentially hurting Chinese exports. The Yen is moving inversely to the dollar, helping Japanese exporters but it is difficult for American investors to capitalize on Japanese stocks right now since Japanese stock appreciation is offset by Yen depreciation.

Specific Stocks: Just because emerging market currencies are falling doesn’t mean that emerging economies are slowing down. It does mean that emerging market growth should be played differently. Consider Bucyrus (BUCY), it is the best of breed manufacturer of super-heavy mining equipment such as titanic electric shovels used in strip mining. It just bought the mining division of Terex, a rival that makes heavy mining equipment such as gigantic trucks and cranes. BUCY is levered to emerging market mineral consumption but it really doesn’t care too much about currency fluctuation since it is a quasi-monopoly (especially now after the Terex purchase). Whenever I buy shares of BUCY I also buy the global steel index (SLX) as a simple hedge against BUCY’s Achilles heel: high steel prices. SLX is levered to emerging market growth in its own right. There is no futures market for steel, therefore steel prices rise because of fundamentals, not the carry trade (unlike copper). Now think about Coca-Cola (KO). It is highly levered to emerging markets, but it is adversely affected by a strengthening dollar since it is not a monopoly (anybody can make fizzy sugar water). In general then, US companies that make products for emerging markets that cannot be easily substituted are the way to go.